Author: Veronica Fulton, CFA
Movement in the equity markets for the second quarter of 2024 largely echoed what we saw in the first quarter of the year. The S&P 500 continued its advance, rising 4.28% to new all-time highs. Tech stocks led the market higher, with the NASDAQ 100 up nearly 8%. The major contributors were large-cap growth stocks. The Magnificent 7 and semiconductor companies dominated markets as optimism around demand for AI continued to climb. Across market caps, growth outperformed its value counterpart, as measured by the Russell indices and large cap outperformed mid cap, which outperformed small cap. Although the broader market continued to make new highs, the narrowness of participation has been staggering. We’ve grown more cautious around growth names at the margin. Accordingly, we’ve reduced our overweight in large cap growth across our asset allocation strategies as we anticipate a rotation to areas that have significantly underperformed.
Over the quarter, sentiment remained bullish and valuations stretched – both have bearish implications. However, the accuracy of these indicators can be inconsistent in terms of timing. Hope springs eternal, and market participants can remain excessively optimistic for long periods of time. Another driver of investor optimism, in addition to AI, has been the soft-landing narrative. Federal Reserve Doves have declared victory as the disinflationary trend progresses. In June, headline CPI actually contracted -0.1% from the prior month, adding to a string of improving inflation data throughout the second quarter. Stickier areas started to give way, as we saw inflation slow in both housing rentals and new vehicle prices. We even saw deflation in used car prices. Recently, Fed Chair Powell said Q2 data has given policymakers more confidence that inflation is headed back to their 2% target. Now that inflation has come down, the Fed can look more closely at the other side of their mandate – maximum employment.
We’re seeing signs of normalization in the labor market as the imbalance between demand for workers and supply subsides. Job openings are coming down and quit rates are stabilizing. However, there are cracks – unemployment has been rising. June’s 4.1% unemployment rate is already at the Fed’s December target.
Additionally, the Sahm rule, an economic indicator that signals the onset of a recession, is close to triggering. The rule is based on the notion that once people start to lose jobs, they will cut back on spending which causes more job losses in the form of layoffs, having an effect. However, this has yet to play out. Small cracks in the labor market did not have a significant impact on consumption in the second quarter. Retail sales data for the month of June came in flat, but higher than expected. Additionally, the data point for May was revised higher. Consumption, which accounts for the majority of GDP, remaining steady was welcomed news, and markets rallied in response. Consequently, we saw upside revisions to second quarter GDP, although it is expected to come in slightly below trend.
At present, Fed Fund futures are pricing in 3 rate cuts this year with over 50% odds, starting in September. That may be too dovish in our view. Typically, a Fed that is aggressively cutting would imply economic conditions are deteriorating – bearish for stocks. On the other hand, a slower pace could indicate that the Fed is adjusting the federal funds rate to get closer to a policy stance that is neither restrictive nor stimulative, but neutral. The latter would coincide with a soft landing. Given that the economy is slowing but not significantly so, we think this scenario remains likely.
All things considered, the second quarter was characterized by a strong but narrow market, normalization in labor markets, and slow but stable growth. Evidence of both the market and economy running out of steam started to unfold but to a small degree. All eyes are on earnings as 2H 2024 is expected to be backloaded, and earnings of companies with compelling AI initiatives are forecasted to buoy markets further. Additionally, we continue to monitor the health of the consumer for any signs of significant stress. As always, we remain nimble and flexible.
Source: FactSet
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